I specialize in Private Construction Lending. Below is something I put together that explains to the borrower (or Real Estate Professional) how our unique product works. First Horizon employees and Loan Officers please email me if you wish to use this letter.
What Does "OTC" Mean?
OTC is an acronym for "One Time Close" - Well, what does that mean? Traditionally banks offered private financing for residential construction through a three step process. First, you were approved for and closed on a Lot Loan. This secured the property. Second, you were approved for and closed on a Construction Loan. This allowed you to begin building. Third, you were approved for and closed on your permanent loan (30 Year Fixed, 5/1 ARM, etc) by refinancing your Construction Loan - For all three occasions a full assortment of closing costs were required as they were considered individual loans. This also meant that you were required to make full payments on these balances before the money was even used. In the end you made two separate payments with different interest rates - One for the land - One for the home. Normally the Lot Loan was only good for five years and would also need to be refinanced at a later date. Most lenders charge "Prime plus" - This means that today your rate would be anywhere from 9.250% to 10.250% - The Prime Rate is currently 8.250%. When a lender charges Prime Plus One or Prime Plus Two that is how those rates are reached. This is because banks do not like to own "Raw Land" - At First Horizon Home Loans our Lot Loan is specific to our construction program, creating a safer scenario for the investor, and this allows us to lower the rates we offer our customers.
By using First Horizon's "One Time Close" program you will only pay fees one time. This significantly lowers the cost. You will have the land, construction, and permanent financing taken care of before you even break ground. In the end you will make one payment, at one interest rate, which is based on the program of your choice. Instead of making full payments on money you have yet to borrow, you will make interest only payments on what you have used thus far, and can even choose to avoid those payments all together. We treat this one loan as a refinance, making no money down a likely possibility, and means that even the closing costs can be financed. We do this by basing your loan on the "As Completed" or future value of your home. As where most lenders will only loan a percentage of the cost to build (cost of acquisition) - Which means that with another lender, you will come in with 20% down (plus closing costs), and receive a loan for 80% of the cost of construction - We instead extend alternative options. You as the borrower are in control, you choose which options you like, and discard the options you dislike.
Now, we will move on to an overview of your basic options. These two options reflect what type of loan you desire during construction. They have an impact on what interest rate will be used during and after construction as well as the cost of your build overall. Please review them carefully and feel free to call me if you have any questions regarding this information.
Option One: "Prime Plus Zero"
This option will allow you to choose a program for permanent financing but will not lock in your interest rate until construction is completed (at modification) - This means that you will be "Pre-Qualified" for the program to be used at the end of construction but also means that you will not have your rate locked at this time. With this option you would pay today's Prime Rate (8.250%) during the course of construction and your permanent rate will "Float" with the current market. At the end of construction (depending on what points and fees you paid initially) your loan would then be fixed to the rate associated with that loan program.
You have already been qualified for this program which means the process to convert the loan is simple and streamlined by First Horizon. One advantage to this program is that your closing costs are "bundled" into one fee of 2% (two percent of your loan amount) - Another advantage of this option (in a stable market) is the possibility of a lower interest rate. This is because you did not pay an "Extended Lock" fee to keep a specific interest rate during the course of construction. That fee is normally built into the interest of the loan which slightly increases the rate. Though you may choose to pay the "Extended Lock" fee at closing to avoid its impact on your interest rate; the cost is still passed on to you the borrower.
Option Two: "Firm Lock"
This option allows you to choose a program and also locks your interest rate during and after construction. As stated above, this may have a slight impact on the interest rate but will provide you the security of knowing what your rate will look like after your home is completed. This also means that you would pay (for example) 6.750% during construction versus Prime (8.250%). An additional fee will be collected by First Horizon Construction Lending of 1% (of the loan amount, or a maximum fee of $5,000) in order to use this permanent rate during your build. This means that for a longer build you will pay less in interest during construction.
In an unstable market this will protect you from possible increases in interest rates during the course of construction. This is important if your build may take a year or more to complete. It is very difficult for anyone to calculate where the market will be in that length of time. When using this option the interest rate will be affected by the length of time your project will take. The less time your project will take to complete, the fewer fees you will pay to extend your lock, and the lower your interest rate will be calculated. Please keep in mind that giving yourself a little buffer room beyond the expected time to complete your home is advisable.
Both options still leave room to change programs at modification if necessary. You have been "Pre-Qualified" for the intended program so additional information may be requested in order to use another loan program; but will not be treated as a refinance with new fees and closing costs. Both options are interest only during construction and you are only required to make payments on the outstanding balance (how ever much you have borrowed to that point in construction) - So during construction both options will act much more like a line of credit then a conventional home loan.
Choosing between these two options is the first decision we will need you to make. Please note that the difference in rate (at the end of construction) between these two options is not that substantially different. For example: Based on today's rates (a 30 year fixed if locked for 365 days) a loan locked upfront would be at 6.750% - A loan that had not been locked and now was at the end of construction (at modification) would have an interest rate of 6.375% - Which is only a difference of .375% - The easiest way to calculate which option makes the most sense for your personal needs is determined by the length of construction. If you are only going to need a few months then paying less in fees and taking a small gamble on the rate may be the best choice. If your build may take a long time then the difference in rates and fees may become a void issue.
The parameters of your loan are based upon the appraised value of your new home. First Horizon is unique in that we base these parameters on the "Future Appraised Value" of your home. This allows us to treat your transaction very similar to a refinance. If you are building a home that is going to be worth $500,000 and is only costing you $400,000 - Then you already have a 20% down payment (or 20% in equity) - First, this means that you have made a sound real estate investment. Second, this means that you can complete a "No Money Down" transaction. Now, not all construction loans are created equal, but I have to this day never found a construction loan that didn't at least leave a 10% down payment built into its equity.
In order for this to be discovered, for a program to be chosen, for a rate to be calculated, and reserves (see below) to be determined; an appraisal must be ordered by First Horizon.
In order for an appraisal to be ordered by First Horizon there are a few items that will be required in order for an appraiser to create an accurate report.
•· A cost breakdown provided by your contractor (must include taxes)
•· Plans and Specs reflecting the cost breakdown and the materials that will be used during construction.
•· A written contract reviewed by First Horizon Construction Lending reflecting the builder's fees and estimation.
There is another reason why an appraisal is required before the loan can be processed. Depending on the appraised value of the home versus the cost of construction per the contract provided by your builder, a few additional items may or will be added to the loan, based on the difference (in equity) between those two figures. The first is optional and is called the "Interest Reserve" - This option allows payments to be "made for you" during construction. The amount of interest due on a monthly basses as determined by the outstanding balance (remember it more like a line of credit during construction) will be put into this reserve and added to the loan amount at the end of construction. This is a good option for some borrowers because it puts less demand on there monthly obligations during there build.
The second reserve is called the "Contingency Reserve" - This is required by Washington State and First Horizon Construction Lending. This reserve is built into the structure of your loan in order to protect you if the cost of your build exceeds the original estimate or there is a costly change to your plans. It protects you by making funds available if either of these situations occurs, so that you are not required to "come up with the money," or exceed qualification for the loan program you have chosen.
Another factor in your construction loan is the permitting process. Be sure to not only speak with your builder about this matter but your loan officer as well. Your construction term is pre-determined and is a part of your loans structure. Your construction term will begin the day that your loan closes. This means that the permitting process needs to be addressed before the loan closes.
If you have chosen to lock in your interest rate during construction then you have the option of using a "Float Down" - This means that if your interest rate improves during the course of construction, at completion (within the last 60 days) you can lock your loan at no additional fee to a lower interest rate, and keep that interest rate for the term of your loan. Once your home is complete a final inspection will take place and an appraiser will confirm that you built the home he or she original appraised. You will then receive documents to be notarized and signed in order to complete the process. This is called "Modification" - It acts to convert your construction loan into a permanent loan without the need to refinance. That is the final stage of the loan...Now you can simply relax and enjoy your new home.
Remember, you can call me anytime regarding this information. I value your questions as much as I value your business.